An Affiliated Nightmare: Part II

Could language in the margin tax send innocent Nevadans to federal prison?

The phrase “affiliated group” — an admittedly dry term that, until now, has been exclusive to the lexicon of tax accountants — could soon be haunting everyday Nevadans who never held much interest in tax law.

That’s because the margin-tax initiative that will appear on Nevada’s 2014 ballot defines this term in a way that could force innocent small-business owners into federal prison — through no fault of their own.

Such a scenario may sound extreme, but the proposal’s poor drafting, coupled with federal racketeering laws, could bring it about.

The margin tax defines firms that are engaged in a “unitary business” — those offering similar products or different products along a single supply chain — and which share any common owner as an “affiliated group” of businesses. These firms are required to commingle financial information and submit a single, combined tax return for the entire group.

The definition is written so broadly that even firms that have a single stockholder in common could be considered an affiliated group.

A less extreme case, however, would be a general partnership in which each partner holds only minority ownership, but also has additional business interests to which his or her partners are not a party.

Picture an automotive repair shop, for example. Imagine the business was created by an old mechanic and his son, who are equal partners along with a lawyer who helped to launch the venture. The business has enjoyed several years of success and the father has used the proceeds to also become a minority partner in a local auto parts distributorship. The lawyer, meanwhile, has long held a variety of business interests to which the mechanics are not privy.

Because the elder mechanic holds a minority interest in two general partnerships, the margin tax forces both businesses to consolidate their finances and submit a single tax return.

Understandably, this angers the mechanic’s partners at the auto parts distributorship, who have nothing to do with his repair shop.

But then, looking more closely at the margin-tax law, they realize that many of theirown separate business interests could bring additional firms into this “affiliated group.”

Say that they are also part-owners in outside businesses that could plausibly be construed as belonging to merely the same industry or supply chain. Then, all of those businesses would become part of the same “affiliated group” to which the elder mechanic’s repair shop belongs.

Indeed, this reality could extend out to third- and fourth-tier businesses, in which the mechanic’s distributorship partners have partners in outside businesses that also have partners in other outside businesses. This network of firms spirals rapidly until many people who have never met nor done business with each other must now consolidate their finances for a joint margin-tax filing.

From an administrative standpoint alone, such a scenario sounds frightening.

But that’s not where the real nightmare lies: When one is compelled to commingle finances with strangers, much greater dangers await.

Let’s say the lawyer in this story has been helping to set up businesses in the automotive industry for years, and maintains partial ownership in many of these firms. As it turns out, however, a few of these firms are illegitimate — fronts set up to launder money for the mafia.

An FBI investigation ensues and the offending parties are apprehended. But here’s where it gets tricky: Federal racketeering laws would implicate any firm whose finances have been commingled with those of a money-laundering operation. As such, honest business owners who have been forced into an “affiliated group” with the offending firm in order to file taxes together — yet who have broken no laws themselves nor had any knowledge of the money-laundering operation — could face federal indictment along with possible fines and prison time.

Federal prosecutors, of course, could use discretion and decline to file charges against such innocent business owners. However, the interaction of federal racketeering laws such as RICO (Racketeer Influenced and Corrupt Organizations Act) with the flawed drafting of Nevada’s proposed margin tax makes this fantastic-sounding scenario into a plausible likelihood.

No one should go to prison for crimes they didn’t commit. But because the margin tax could force innocent business owners in Nevada to mix their finances with strangers, there’s no telling what the outcome could be.

Geoffrey Lawrence is deputy policy director at the Nevada Policy Research Institute. For more visit http://npri.org.

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Geoffrey Lawrence is Nevada's Assistant Controller where he oversees the state's financial reporting and transparency efforts along with Nevada's elected controller, Ron Knecht. Geoffrey is a frequent commentator on public policy in print, radio and television news in Nevada and his work appears regularly in publications around the state and the nation. Geoffrey previously served as NPRI's Director of Research and Legislative Affairs until December 2014. He holds an M.A. in International Economics from American University in Washington, D.C. and is currently pursuing an M.S. in Accounting from Western Governors University.